The US government’s economic response to the COVID-19 crisis has included making funds available for small businesses to keep paying their employees while times are tough. But Chicago Booth’s Michael Minnis says that the way the program is designed may give an edge to certain businesses who are better positioned to access those funds right away—which may in turn mean various industries have winners and losers determined by something other than regular economic competition.
Businesses that have fewer than 500 employees employ about half of the overall workforce. If they don’t have access to capital, then they have to lay those people off, and we create frictions in the system when we’ve got unemployment for those individuals.
The challenges those businesses are facing right now are, first of all, a huge demand shock. Small businesses are disproportionately services oriented. And people, because we need social distancing, have cut off a lot of that services part of the economy. And so first and foremost, they face a huge demand shock for the goods and services that they’re selling.
As a result, they have to search for capital to try to keep their operations going, and that’s kind of difficult when they don’t have revenues coming in the door.
The stimulus package, the PPP, the Payroll Protection Program, was designed to provide that capital to these businesses to keep their employees in the firms. So rather than having to rehire when that demand shock is settled, they’ll have these employees still on their payroll and in contact with those small businesses. So it’s designed and set up so that these small businesses can still fund the payroll—primarily, although it can be used for other types of expenses—so that those small businesses are ready to roll once the health issue has abated.
Now, the program’s set up and designed such that it’s first come, first served. So they allotted $349 billion, and once that $349 billion is allocated, at least for now, that means the funds are gone. And as a result, what is going to happen here is there’s an immediate demand for this capital.
Anecdotally—and we have to go with anecdotes at this point because there’s not a lot of data out there yet—there are businesses flooding banks right now with applications for this. And the problem with first come, first served is the following: those borrowers who are in a better position to take advantage of this are going to get access to those funds first. If the program’s designed to hit a pause on the economy—basically what we want to do is set all the small businesses up such that they return to operations as they were prior to this—if those businesses which are in a better position to take advantage of this program do so, then what’s going to happen is that they’re going to be around when this issue is done and we won’t have hit a pause.
In fact, we’ll have what we call heterogeneous effects on these firms. Those that are ready—they have business relationships with their banks, they have their documentation ready, so they work with their accountants to have their payroll, their taxes done—those are the ones that are going to be able to get first in line to this. And if they get access to this $349 billion before the others do, then they’re going to be the ones that are going to survive coming out of this.
So part of the issue with creating a cap on the amount of funds available is, you get a run. A run on demand for this capital. And that could result in winners and losers.
I was talking to a bank president this morning who felt like a toilet paper salesman. And the reason for this was because if people feel like there’s going to be a shortage of these funds, those businesses are going to come in as quickly as possible and demand absolutely as much as possible. Even if they may not need it, they’re going to hoard these funds, such that they can survive through this point in time without the certainty of knowing what’s going to happen when these funds run out.
At this point there’s a lot of frictions in making this happen. In theory it should be easy to get these funds because the documentation requirements are not overly onerous, the SBA is going to guarantee these funds, and so in theory the banks aren’t going to be on the hook for it.
The problem is that nobody was set up to take this kind of flow this quickly. This program is more than 10 times the size of what the SBA does in a normal year. The size of this program itself is roughly the size of the entire stock of loans in the sub-$1 million category for commercial lending. In other words, this program itself is about the size of standard commercial-industrial small business lending. So it’s a massive undertaking for the banks and the SBA to really take this on.
So we’ve got a lot of frictions, we’ve got hoarding of this capital, potentially, because of these businesses showing up to do it, and the issue is who’s going to win and lose from this in some sense, because those borrowers who are ready to go, they have their taxes done, they’ve got good banking relationships, are probably going to get in the front of the line here.
One of the things I’ve learned from my prior research studying the housing crisis, and specifically we looked at construction firms, was during that time there was obviously a big demand shock for construction of housing in the middle 2000s. And what we saw was a big surge of construction activity.
When that demand shock hit construction firms and nobody was wanting to build houses, what we saw was a massive washout of construction firms at that time as a result of the big negative demand shock. That may have been fine—what we saw is that the stronger construction firms were the ones that survived. So those construction firms which had banking relationships, had audited financial statements, were much more likely to survive that.
The difference between the construction kind of housing boom and this one that I see is that if one wants to think that we were in equilibrium in terms of the businesses in say January and December, we didn’t need to eliminate stronger and weaker firms today as perhaps needed to be done in the construction industry back in the mid- to late 2000s.
This demand shock was not brought about by overheating of a particular sector of the economy, but rather because of the COVID situation and not because of excess demand. And so ideally what one would want to do is pause the economy and let those strong and weak firms survive based upon their own economics and not as a result of their greater access to capital because of the situation, or heterogeneous demand shocks.
What we want to do is keep a rich environment for these small businesses to thrive and not just allow either the governmental system or the disease to pick small business winners and losers. Rather, standard economic competition should be doing that. My concern is, when we set up this program and this program results in heterogeneous results for these small businesses, winners and losers are going to be decided by something other than standard competition.
We want to reduce the frictions for these businesses to survive, and let them come out of this in a position to compete under standard economic conditions.